Tariffs May Create Opportunities in Investment Grade Credit, But Tread Carefully

• While we don’t believe the Trump administration’s tariffs pose a big concern for investment grade credit, we believe investors should tread cautiously.

• We would view widening of spreads as a buying opportunity, and believe active managers such as PineBridge are well placed to tap these opportunities.

• Most credit sectors are likely to feel the impact of tariffs, with autos the most exposed. We view the financial and communications segments as the most insulated.

Given the tumultuous opening months of the new Trump administration in the US, investors are understandably concerned about what aggressive tariff actions and the flurry of other policy changes will mean for the economy and markets – both now and over the longer term. While we don’t believe investment grade (IG) credit is at significant risk from the tariff policies now unfolding, we think a cautious approach is warranted – and that active managers employing thoughtful credit selection may help avoid exposure to potential risk and tap potential opportunities.

Here we answer investors’ frequently asked questions on the tariffs and their impact on investment grade credit.

What is the more likely near-term result of the new administration’s tariff policy: higher inflation or lower growth?

We think a combination of the two is going to play out over the next six to 12 months. First, higher tariffs will drive up consumer prices and lead to a pickup in inflation. We expect this to be more of a one-time hit, like a tax effect on disposable income, rather than a long-term theme.

In the US, the tariffs, along with policy uncertainty, government layoffs, and weaker sentiment, will likely add headwinds to near-term growth and drive a moderation to below 2% quarter-over-quarter growth in the first quarter.1 We believe certain policies coming out of Congress – such as deregulation, a tax-cut extension, and some possible additional cuts, likely passed by midyear – would be pro-growth in nature and could temper the negative near-term outlook.

Will the Federal Reserve react swiftly to shifts in the growth or inflation trajectory, or take a wait-and-see approach?

The Fed left rates unchanged at its 19 March policy meeting, as widely expected. The more notable shifts were downward revisions to the Fed’s growth forecasts and upward revisions to its inflation projections. Chair Powell, in his press conference, acknowledged that tariffs are already affecting the economy and have been factored into economic forecasts. He said the base case remains that tariffs will have a transitory impact on inflation, but noted significant uncertainty about that outcome. While the new dot plots continued to show two rate cuts this year, we think the Fed will take a wait-and-see approach before reacting with rate cuts. Ultimately, we believe the Fed wants to lower rates, as it views current conditions as somewhat restrictive. It is already working to improve conditions by cutting the monthly cap on its Treasury securities redemptions to $5 billion from $25 billion, starting in April.

How will corporate bond spreads react?

Within US investment grade credit, we expect tariffs to spur a modest widening in spreads, given that corporations derive about 30% of revenues from outside the US (see chart).

About One-Third of Revenues for the US IG Index Come From Outside the US

Source: FactSet, Bloomberg, Barclays Research as of 6 December 2024

The auto sector remains the US IG credit sector most exposed to tariffs. The impact on other sectors should be relatively modest, and issuer-level risks remain to be assessed, particularly once there is more certainty around trade policy. US IG credit spreads have widened from the tights of around 71 basis points (bps) reached earlier in the year to around 89 bps as of the end of the first quarter.2 We think there is still some potential for further spread widening, perhaps by another 10 to 15 bps, as more tariffs are implemented and we see their impact on both margins and prices.

Nevertheless, we expect spreads to remain in the 70 bp-100 bp range for much of the year, based on our view that the economy is midcycle with relatively robust fundamentals and with valuations that are likely to remain supported by attractive all-in yields. As lower short-term rates are still expected, foreign interest in the asset class should be bolstered by the prospect of lower hedging costs. Thus, despite valuations that are exceeding longer-term averages, we continue to have a slight bias toward risk. That said, we remain selective across industries and issuers, as opposed to taking a broadly risk-on stance.

Which sectors or asset classes are best positioned to ride out the storm?

Generally speaking, in an environment of uncertainty, a higher-quality portfolio is likely to perform better. In the US investment grade credit market, we view prospects for the financial and communications sectors as more favorable due to their strong fundamentals and relative immunity from the impact of tariffs. US Treasuries are also attractive during periods of elevated volatility and sharp risk-off periods. These bonds also help manage portfolio duration relative to the benchmark without adding unintended credit risk.

Taking a measured approach

Despite the uncertainty and investor concern surrounding the Trump administration’s tariff policy, we don’t believe these measures pose an outsize risk to investment grade credit. However, we believe a measured approach is warranted, and that active managers who employ careful credit selection may help investors avoid exposure to potential risk. Finally, in times of uncertainty a higher-quality and more liquid portfolio will provide flexibility to add risk as opportunities arise.